A forward contract is a market transaction that calls for future delivery of a commodity at a price determined on the initial trading date. It is designed to protect the buyer and the seller and reduce their risks.
For example, consider a farmer growing maize and a canned food industrial willing to buy this year�s harvest (let�s say in September N) in order to produce canned maize. Both the farmer and the buyer are facing a major problem threatening their profits: price and its fluctuation that might be very volatile (maybe very low) for the former and unpredictable (maybe very high) for the latter.
To solve this problem and reduce risk, both can enter a forward contract (for example in January N) in which the farmer is required to deliver the maize in September N at a fair price that both agree upon in January N, and this regardless of the market price of maize at the delivery time. So basically, it is a sort of delayed delivery sale of some commodity with predetermined transaction price.
Futures
A future contract is a sort of forward, an agreement between two parties: a short position, the party who agrees to deliver an asset, and a long position, the party who agrees to receive it at a predetermined fair price. In the above scenario, the farmer would be the holder of the short position while the industrial would be the holder of the long position.
The major difference between futures and forwards is that futures are liquid and traded on an exchange that standardizes the transactions. Futures markets buy and sell futures contracts rather than trade in physical commodities; the price per unit, type, value, quality and quantity of the commodity in question (maize in our example) have to be specified, as well as the expiration date of the contract.
Swaps
Swap means exchange, and in finance, it means money exchange. As a derivative, a swap is actually an exchange of future cash flows that could be interests on bonds, in this case we are talking about interest rate swaps, or just cash in different currencies, and in this case we talk about foreign exchange swaps.
Foreign exchange swaps can protect two parties from currency exchange rate risks. For example, consider company X based in Paris, buying from and selling items to company Y based in London. X has to pay Y in Pounds while Y has to pay X in Euros, but what happens if exchange rates fluctuate too much? To limit these risks, both companies can enter a swap contract by which they agree to do the transactions at a predetermined, agreed upon exchange rate, which will be fixed for a period of transaction time.
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